Joel Greenblatt: "The Little Book that Beats the Market" | Talks at Google

SPEAKER: Joel Greenblatt, our guest today, is the co-founder, CEO and co-CIO of Gotham Asset Management. We couldn't be more excited and grateful that he accepted our invitation and is here. Thank you very much, Joel. To you. JOEL GREENBLATT: Thank you very much. Thank you for coming today. I really appreciate it a lot. I've never been here before so I'm looking forward to my tour immediately after, so thank you. So even Warren Buffett says that the vast majority of people should index, and I agree with him. So are there any questions or do I have time? On the other hand, well, I have time, so again, Warren Buffett doesn't index and neither do I.

So I thought I'd tell you why, and then maybe you'll have more information to decide for yourself what makes sense for you. And in some sense, it shouldn't be so difficult. In fact, I had a friend who is an orthopedic surgeon and is in charge of a group of orthopedic surgeons. And he asked me to speak to them at a dinner, about the stock

market

. And I said, Okay, these are smart, educated guys. You can understand these things. And I spoke for about 35 minutes, explaining how the stock

market

worked and everything else. And then I started getting questions like, oil went down $2 yesterday...

What should I do? Or a market went up 2% yesterday. What do I do about it? So my interpretation of those questions was that I had simply crashed and burned. So last year I was lucky enough to be asked to teach a ninth grade class, to a group of kids, mostly from Harlem. And I had just crashed and burned with orthopedic surgeons, and I didn't want to do that with kids. So I started thinking about what I could do to explain the stock market a

little

better. So I walked into class the first day and handed out a stack of three-by-five cards.

And I brought this jar of jelly beans right here, and I asked... the students passed the jar of jelly beans. I asked them to count the rows, do whatever they wanted, and write their best guess of how many jelly beans were in the jar. I picked up the three-by-five cards and then walked around the room, one by one, toward each of the children in the room. And I said, listen, you can keep your assumption or you can change it. That depends on you. And I went, one by one, around the room and asked people how many, and I wrote down the different guesses.

It turned out that the average guess for the three-by-five cards was 1,771 jelly beans. There are 1,776 jelly beans in the jar, so it was pretty good. When I looked around the room, I assumed it was 850 jelly beans. And I explained to them that the stock market is actually in doubt, because everyone knows what they just read in the newspaper or what the guy next to them said, what they saw on the news, and they are influenced by everything. that surrounds them. And that was the second assumption, and that's the stock market. The cold, calculating guess, when they were counting rows and trying to figure out what was going on, was actually the best guess: That's not the stock market.

But that's where I see our opportunity. Once a year in my class at Columbia, at least for the last five or six years, someone raises their hand and asks a question like this: Hi, Joel, congratulations. You've been doing this for 35 years and have had a good track record. But now there are more computers, there is more data, there is more capacity to do calculations. And isn't the party over? Isn't it just more hedge funds? It's just a lot more competition. Isn't the party over? So, my students are usually second-year MBA students; I would say that the average age is approximately 27 years.

So I just answer it this way. I tell them, let's go back to when you learned to read. Let's take a look at the most followed market in the world. It would be the United States. Let's take a look at the most followed stocks within the most followed market in the world. That would be the stocks in the S&P 500. Let's take a look at what's happened since you learned to read. So I tell them that from 1997 (when they were 9 or 10 years old) to 2000, the S&P 500 doubled. From 2000 to 2002, it was reduced by half. From 2002 to 2007, it doubled.

From 2007 to 2009, it was reduced by half. And from 2009 to today, it has roughly tripled, which is my way of telling you that people are still crazy. That was just the last 17 years. And I'm going short, because the S&P 500 has an average of 500 stocks. If you lift the covers and look underneath what's going on, there is a huge spread of those 500 stocks between those that, at any given time, are in favor and those that are not. And then there's a wild ride under the covers. If you look under the covers, there's a wild ride for those 500 stocks at any given time.

And doubling and halving, doubling and halving with an average of 500 stocks really eases the path. Then there should be a chance. And if you understand what stocks are, and I guarantee this to my students, on the first day of class, I make a guarantee every year. And they come in and I guarantee you this: if they do a good job of valuing a company, I guarantee you the market will agree with them. I just never tell them when. It could be a couple of weeks. It could be two or three years. But if they do a good job of valuation, the market will agree with them.

Stocks are not pieces of paper that bounce up and down and to which complicated ratios are applied, such as Sharpe ratios or Sortino ratios. Stocks are shares of ownership in companies that you are valuing and, if you want, try to buy at a discount. So if you believe what Ben Graham said, that this horizontal line is fair value, and this squiggly line around that horizontal line is stock prices, and you have a disciplined process for buying, perhaps, more than you expect. corresponds when they are below the line and, if you wish, sell or short sell more than what corresponds when they are above the line, the market throws us offers all the time.

The reason people don't outperform the market is because of behavioral issues. There are agency problems. But it's not because we don't have those opportunities. I'll show you briefly...let me tell you how we value the stock. It's not very difficult and I think most of you will understand it. And I think the best example that seems to resonate with most people is thinking about buying a house. And to simplify the numbers, let's say someone asks $1 million for the house. They want to sell and your job is to determine if it is a good deal or not.

So there are certain questions that you would ask. One of the first questions I would ask is, well, how much could they charge me in rent for that thing? In other words, if you rented that million-dollar house, how much rent would you charge? If you were to charge $70,000, $80,000, $90,000 a year (7%, 8%, 9% return on that house) that's one way to value it. And what is the next question you would ask? I'm pretty sure I know which one it would be. What are the other houses on the next block and in the next town for? How does this compare? How relatively cheap is this, compared to all my current options?

So that's what we do. We look at how relatively cheap this business is, compared to other similar businesses, relative to the entire universe of options that I have. We do that. We also go back in history, we look at how this company or this house has traditionally been valued, compared to others in the neighborhood or compared to other communities. And how is it valued now? So the absolute and relative value measures (absolutely cheap on a rental basis, relatively cheap on all the different types of measures that make sense to you) now, you wouldn't use any of these measures alone.

If they just used a relatively low price, if some of you remember the Internet bubble and bought the cheapest Internet stocks, that was not cheap. It was just cheap compared to all the other crazy priced stocks at the time. But we use our absolute and relative value measures as checks and balances against each other to try to focus on fair value. So when you do this, I just want to show you a simple graph. This is actually a study we did on our valuation methodology, very similar to the way I just said we value a house.

Here's how we looked at the 2,000 largest companies in the US over a 20-year period. This was from 1992 to 2012, and we rank them daily from 1 to 2000, based on their discount in our value assessment, using these metrics. The x-axis here (you probably can't see it) is just a valuation percentile. All of this means that if you were in the bottom left corner and you were in the first percentile, it would be the 20 companies at any given time, of those 2,000, that measure the cheapest, according to our measures of absolute and relative value. Go to the 99th percentile: they would be the 20 companies that measure the most expensive of those 2,000.

The y-axis is the average annual return over those 20 years. What this chart simply says is that, on average, the stocks that fell into our first percentile, the 20 cheapest, averaged a one-year return over those 20 years of 38%. Stocks that ranked in our second percentile averaged a one-year return of about 37%. And then we go down to this best fit line, which we always say we don't mind missing out on when we make extra money. And then when we measure something more expensive, the future annual return falls. And if you were sitting in my class at Columbia and said, hey, does anyone see a long-short strategy that I could follow if I could predict in advance which stocks would do best, second best, third best, in order, and not you said, I guess I would buy these guys here in the top left corner and sell these guys in the bottom right corner.

If you didn't say that, I'd probably kick you out. of class, because it is very simple. That's what you should do. And by the way, that's what we do. The important thing to understand is that stocks are shares of ownership in companies, okay? Now, by the way, that beautiful graph I showed you with the 90% fit...why doesn't everyone do this? Well, unfortunately, it doesn't seem like that when you're living that. That's an average of more than 20 years. If I showed you a clip from three or four years ago, it would fit well. It could be 0.55, 0.6 or something like that.

But it's not going to be very cooperative, is it? If what we did worked every day, every month, and every year, everyone would do it. It would stop working, but unfortunately it doesn't. But the reason we stick with what we do even when it doesn't work is that chart, which means that the way we value companies, our measures of absolute and relative value, are roughly how the market values ​​them over the long term. weather. If we were, for example, momentum investors... Well, I'll tell you that for those of you who know what it means, momentum has been studied all over the world for the last 30 or 40 years in the United States.

It has worked pretty much everywhere, not all the time, but on average it has worked very well for 30 or 40 years, and not just in this country. But here's the problem. What if it didn't work in the next two or three years? It may be that we simply have to be patient. It works over time and is cyclical. And that is why it is out of favor and we have to stand firm because it is something that has worked. Or it could be, if it didn't work out in the next two or three years, that the explanation is, hey, it's not that hard to understand.

A stock used to be down here, and now it's up here...it's got some good momentum. And with all the data, number-crunching, computers and studies that have emerged, it's a crowded business. It is degraded. It's not as good as it used to be. And if that's what happened over the next two or three years, I would know the answer to that question. I didn't know which one it was. Should I be patient or has the trade degraded? But if you look at stocks as ownership shares of companies that you value and try to buy at a discount, and that doesn't work out for a couple of years, I'm not going to change what I'm doing.

I'm not going to buy the bottom right corner, I'm going to buy all the money losers and companies that don't make anything or trade at 100x free cash flow. I'm not going to buy them, even if they work in a particular year, and then sell the ones that are cheap, relative to everything, get me high rents and everything else. I'm not going to change my strategy and I think stocks will eventually...not now, but eventually people will get it right. And you may have to be patient. That's really what I have to do. What that chart tells me is that I'm on the right path, which means that's our true north, and we just have to be patient to get there.

The reason these simple metrics are not eliminated is that the example I usually use for arbitrage is, oh, you see gold in New York at $1,200 and it is sold in London simultaneously at $1,201. Well, an arbitrageur sitting at a trading desk somewhere will see that and buy gold in New York at $1,200 and push the price up a bit. At the same time he will sell gold in London at $1,201, which will drive the price down. And they will converge somewhere in the middle, and it will happen so quickly on an operating table thatYou won't even be able to see it.

But what if I told you that today you could buy gold in New York for $1,200 and that at some point in the next two or three years you will make money, but you could lose 20% of your money while you wait? There's no guy sitting at a desk anywhere who can really do that. And, frankly, time horizons are getting shorter. It used to be that when I was younger I would get quarterly statements and most people would throw them in the trash. You can now check your stock price 30 times a minute on the Internet. Maybe some of you do.

And time horizons are shrinking, and we're just playing time arbitrage. We are being patient, buying good deals cheap and waiting for the market to recognize the value we see. But it takes some work to value companies. And let's say you don't want to do that. You have a day job. I guess everyone here has a day job, so you don't want to do that. So one thing you could do is try to find someone good to do it for you, right? I'm showing you that this opportunity exists. Maybe someone can do it for you. And what you should probably look for when you're looking for that person is someone who has a good investment process that makes sense for you.

The problem is, for most active managers, if you think about their challenge: When they pick an individual stock, they have to think that they have a variant hypothesis about why that stock has a different price than it should have. And I can tell you I've been doing this for over 35 years and it's very rare. I have almost never bottomed a stock, nor have I bought it at the absolute bottom. So, more than 99.9 percent of the time, a stock drops after I bought it. And there are really only two reasons for that: one is that I was wrong.

The other is that I simply need more time for my thesis to develop, okay? Now, as an external allocator, you don't really know what the thesis of the individual action was. Sometimes not even the director himself knows. When things go against each other, all kinds of agency problems arise. You have people to answer to. You have behavioral problems, naturally, you start to doubt yourself. Sometimes it is not very clear, even to them, what their prejudices are and what they are doing. They did studies that you probably know about why the home team always wins in sports, or at least wins more than it should.

And the original thesis was generally, oh, they're used to court. They slept in their own bed. The fans cheer them on, whatever it is. And when they controlled for all of these variables, the answer turned out to be that referees don't like to be booed, okay? So they don't think they are being biased. I'm sure 99.9% of the time they don't, but they don't like to be booed. And so they're being influenced by... and that's why there's the same problem with an active manager. He has behavioral issues at the agency that he's not sure about. So the allocator doesn't really understand the thesis behind each choice.

It is not clear that the manager is totally impartial when he has a variant thesis that goes against him. And since you don't know the thesis as an allocator, most people... all they have are the returns, and that's what they used. So in an interesting study that came out the day after Thanksgiving, it was interesting to me, probably not to the guys who did the study. Morningstar published a study of its star system. And their star system is based on past performance, letting you know who has done best over the past one, three and five years.

Of course, my interpretation of their study was that our star system is broken. We cannot discern. The last, three, five years of returns don't have much to do with the next, three, five. But that's what everyone uses. I wrote a

book

. I hold it here. It's called "The Big Secret" and I always say that it's still a big secret because no one reads it. And in that

book

, I talked about some studies. First of all, he was talking about the coach with the best performance. I wrote it in 2011, so I was talking about the decade from 2000 to 2010: it looked at the best-performing mutual fund, a study of the best-performing mutual fund for that decade.

That fund was up 18% annually, 100% long US stocks. The market was flat during those 10 years, so an increase of 18% annually is pretty good. Unfortunately, the average investor in that fund, dollar-weighted, managed to lose 11% a year because every time the market went up, people got in. When the market went down, they got out. When the fund outperformed, they added up. When the fund underperformed, they piled on. And they took an 18% annual gain and turned it into a 11% dollar-weighted annual loss. Because? Well, to beat the market, if you beat the market by 18 points, you are doing something different from the market.

You're going to zigzag differently. You cannot do the same as the market. You have to do something different. You're going to zigzag differently. Institutional administrators are no different. Here are the stats on... if you just take a look at the top institutional managers of that decade, the ones that... from 2000 to 2010... the top quartile managers, the ones that finished with the best 10-year record, here are the statistics about them. 97% of those who finished with the best 10-year record, top quartile, spent at least 3 of the 10 years in the bottom half of performance. Not surprising, but everyone, right? To beat the market, you have to do something different.

You're going to zigzag differently. 79% of those who finished with the best 10-year record spent at least 3 of the 10 years in bottom quartile performance. And here's the surprising thing: 47%, about half of those who ended up with the best record, but spent at least 3 of those 10 years in the bottom decile, the bottom 10% of artists. So you know, no one stayed with them, but they ended up with the best record. So it's very difficult to choose an allocator, because you don't know the thesis, so you're using past performances. But when you do that, all you're doing is chasing your tail, getting in and out at the wrong times, so it's very difficult.

What good allocator, usually an institutional allocator, and there are a few of them, should analyze the process and stay with it. But of course there are agency problems on the part of the people who allocate, because even if you're on a really good investment board, and you're an allocator, and you're head of US equities, or you're head of alternatives or bonds, or whatever, you have a reference point. And if you haven't surpassed your benchmark in the last three years, I'm not saying in the good places, you get kicked out. But I say they don't give you a parade, okay?

So it's very, very difficult with that. So one thing you can do is do it yourself. And I wrote this other book that you have, "The Little Book That Beats the Market." And I just made a simple formula that was like jelly beans, counting the rows, crossing and selecting the cheap companies to buy, very simple. And I wasn't spending outside money at the time I wrote the book in 2005; I just wrote the first study we did on how to make something good and cheap. The companies simply made it easy for you to purchase some of them.

And I kept getting phone calls. Hey, could you do this for us? So what I did was create a website that listed the top stocks. It still exists, MagicFormulaInvesting.com. And people were like, yeah, okay. But could you still do this for us? So I created something called formula investing. And I gave people two options. I said, well... I kind of saw it as a benevolent brokerage firm. I said, listen, we'll let you do it yourself. But you have to choose from this master list of 30 or 50 stocks, and you have to choose at least 20 of them, okay?

Don't get into trouble, and you're supposed to invest every quarter, update your portfolio, and do it mechanically. You don't have to buy everything, but you have to buy at least 20. And then the person who was running this for me said, you know what? How about adding a checkbox that says: do this for me and buy it automatically? So as an afterthought, I said okay. We will do that too. So we did this for a couple of years and let me tell you the results. People who picked their own stocks from the pre-approved list of top stocks did quite well.

Over the two years, they increased by approximately 59%. Unfortunately, the S&P was up 62% over those two years. The automatic, do it for me... increased by 84%. So the automatic had beaten the... in other words, just buying the list had beaten the market by 22 points. But by giving people discretion, even though the list was previously approved, simply choosing the ones they didn't like (but they had to buy at least 20) they had managed to get 22%. -return in a couple of years, which is pretty good, and convert it to a return of less than 3%. So do it yourself: I wrote an article for Morningstar called “Adding Your Two Cents Can Cost You a Lot.” And so I just wanted to warn that.

So, another way...let's see, I'll make it quick. I wrote a book mentioned, called "You Can Be a Stock Market Genius." The worst world title of all time, but in it it said something like what Warren Buffett calls, why don't we go for one-foot hurdles, okay? And I opened the book with a story about my in-laws, who used to spend... they had a house in Connecticut and they used to spend their weekends going to garage sales and country auctions looking for bargains, okay? Paintings or sculptures: they were art collectors. And I described what they were actually doing.

And they didn't go to those garage sales and rural auctions looking for... looking at a painting that was discarded, saying, "This guy is the next Picasso." That's not what they were doing. What they were looking for are works of art or sculptures of which they know the artist. Some of your similar works had just been auctioned for much more than you could buy them for, right? They could buy it for 30 or 40 cents on the dollar for the price that just went up for auction. That is a very different question. And what “You Can Be a Stock Market Genius” was was showing you these areas that are ignored.

These are the country auctions and garage sales of the investment world. And these were... I talked about different areas, spin-offs, bankruptcies, small-cap stocks, companies going through recapitalizations, any weird, complicated situation. That's another way, but you guys have a full-time job. That's a full-time job, let me tell you... it's a full-time job. So now we manage mutual funds. I can only tell you some of the struggles we have with investors. We followed that chart, picked from the 2,000 largest companies, and we've had a good track record. But there are years like 2015 where there is a benchmarking problem, meaning the S&P 500 in 2015 was up about 1.3%.

The equal-weighted Russell 2000 is down 10. The equal-weighted Russell 1000 is down 4. So, if you pick from the 2,000 or so largest stocks, a consistent return would be a downturn of 6 or 7, not up 1.3 . So there is a question of benchmarking, but to beat the market, you have to do something different. You are going to zigzag. Everyone knows that. Now we're working on something - we've had something open for a couple of years where we say, okay, we'll start with the benchmark and then add value. And we'll make some compromises to not do it (it's called Index Plus) and to not vary too much from the index.

So you can stay with us, and the thesis was basically: the best strategy for you, which is how I'll end before answering questions, is not only the one that makes sense, but you can stick with it, okay? So you have to understand what you're doing, number one. If you give it to someone else, you must understand what he is doing. And you have to be able to stick with it, so you have to understand it well enough to stick with it. I guess that's what I'll leave you with before I answer questions. And maybe... SPEAKER: Yes, thank you very much.

That was great. Let me set up the chairs. So thanks again. While reading your magic formula book, "The Little Book That Still Beats the Market," I noticed that you mentioned that there were concerns about shorting the most expensive stocks using the same metrics. And I guess you didn't explicitly say that's the path you'd like to go down. And correct me if I'm wrong. And then he also began with the fund investment formula, which he alluded to in his talk. However, what has happened to them? Are you still continuing and what is your vision for the future?

JOEL GREENBLATT: Sure, we open only long-term funds, called formula investing. And we just merge them with our long and short funds. So we have long and short funds that are 100% net long. But when we analyzed their performance, we performed better in bull markets with the 100% long and short funds. We had a long and short overlap in bull and bear markets.Basically, we never did better the other way. So we just merged our simple 100% long with the 100% long that also worked as long-short. So it was just a matter of trying to do our best and manage things.

In fact, we had just been rated the number one fund, we had gotten five stars from Morningstar for our formula mutual fund, and we closed it. And we merge it with our long and short funds. It wasn't really a business decision. It really was a decision in which we want to give our best. And that's why we did it. SPEAKER: So when you talk about long-short, how do you decide between a 1/70/70 spread or a 1/40/40 spread? When you say you have 100% net long, how do you arrive at what the ratios should be? JOEL GREENBLATT: Sure, so what he mentions is that... well, what he means is let's say you give us $1.

We will go buy 1 dollar of our favorite stocks. Then we'll go out and buy $0.70 more of our favorite stocks, but this time we'll combine them with $0.70 of our least favorite stocks. We'll shorten them, so we'll have 70 longs and 70 shorts, and so another cube to add return. And why isn't it 40/40? We chose ratios for most of our funds that we thought made sense, given the volatility you added for the amount of leverage you're adding and the amount you're shorting. It doesn't have much magic. Something that worked well at $1 long with 70/70 or 40/40; both work fine. In our large cap universe, we give people options.

SPEAKER: Mm-hmm... so Joel, there are a lot of questions on the same topic. I guess we can group them into one. People are curious to know what you think of the current market valuation? Where do you see areas of value today? JOEL GREENBLATT: Well, the benefit of having... we have a great research team and we have a lot of history... if you want to think about the S&P 500, those 500 companies. So, we actually go back 25 years and look at each individual company every day for the last 25 years and aggregate them into the S&P 500 weightings. So what that allows us to do is look today: where is the valuation of the company?

S&P 500 today, contextualized, compared to the last 25 years? And what I can tell you is that we are on day 17. It is not a prediction. I'm just giving you some information. The way we value companies puts us in the 17th percentile of faces over the last 25 years. That means the market has been cheaper 83% of the time and more expensive 17% of the time. When it has been here in the past, the annual returns have not been negative. During those 25 years, the market has increased approximately 10% annually. So from these valuation levels, what has happened in the past: over the next year, an average increase of 3% to 5%; in the next two, 8 to 10, so, as I said, it is not a prediction.

But if you want to know what's happened to stock prices at similar valuation levels over the past 25 years, that's what's happened: 3% to 5% positive returns on average over the next year, and between 8 and 10% during the next two. SPEAKER: So there's a question about what you were doing in the first 10 years of investing, when I think you averaged 40% to 50% annual gains after fees. Correct me if I'm wrong. What was the strategy that you and Rob Goldstein were following in those days and what parts of it are viable for the individual investor, compared to the Index Plus strategy? JOEL GREENBLATT: Sure, investing in stocks is about finding out how much a company is worth and paying less, and that hasn't changed.

What makes a company worth something and what makes it cheap relative to that is pretty simple. That's kind of like Ben Graham: figure out what it's worth, pay a lot less, and leave a big margin of safety between those two. Warren Buffett added a

little

twist that made him one of the richest people in the world. He simply said, if you can buy a good deal cheap, even better. If you read Buffett's letters, it is very clear what he is looking for; Anyway, the first thing he looks for is businesses that offer high returns, we call it, on tangible capital.

And that simply means that every business needs working capital. Every company needs fixed assets. How well do you convert your working capital and fixed assets into profits? So the example that I used in "The Little Book," which I actually wrote to explain these kinds of concepts to my kids... I said, imagine you're building a store and you have to buy the land, build the store, set up the display, supply it with inventory. And all that cost him $400,000. And every year, the store makes $200,000 in profit. That's a 50% return on tangible capital. Maybe I should open more stores;

There aren't that many places I can reinvest my money at those rates. Then I compared it with another store. Remember, I wrote this for my kids. And I called that store Just Broccoli. It's a store that only sells broccoli and it's not a very good idea. Unfortunately, you still have to purchase the land, build the store, set up the display, and stock it with inventory. That will still cost you approximately $400,000. But since it's a bit of a stupid idea to sell broccoli in your store, you might only make $10,000 a year. That's a 2.5% return on tangible capital.

And all I'm just saying is that I prefer to own a business that can reinvest your money; All things being equal, I'd rather own a business that can reinvest its money at high rates of return than at much lower rates of return. . And that's kind of the Buffett spin that we bring into the companies we invest in, by being very tough on how companies make and spend their money. Therefore, we tend to have a group of companies that are not only cheap, but also use capital well. And that's really what we're looking for. So we've always done that. "The Little Book" was more of a way to systematize that.

But in “You Can Be a Stock Market Genius,” what did we do in the first 10 years? I wrote a book about it. It was "You Can Be a Stock Market Genius." I was looking for more complicated and unusual things that other people didn't see. Something strange or different was happening. I showed people the corners of the market where they could look for them. The problem there... and there is no problem. It's a big business. But our portfolios were 6 or 8 names, they were 80% of our portfolio. We recovered half of our external capital after five years. SPEAKER: Five years.

JOEL GREENBLATT: We returned all our external capital after 10 years... SPEAKER: 10 years. JOEL GREENBLATT: Between 1985 and 1994, we were fortunate to have enough money to support our staff and continue to manage our money thereafter. Warren Buffett said that a full wallet is the enemy of high investment returns. And so when you have a very concentrated portfolio and you're looking outside the box, where there are smaller situations and things that are more obscure, you're very liquidity limited. That's why we continue to return money, but that's not why we do what we do now. If you are going to handle other people's money, this is what I will tell you with a portfolio that has 6 or 8 names, which are 80% of your portfolio.

Every two or three years, usually within two, Rob and I, my partner, Rob Goldstein, and I would wake up and discover that we just lost 20% or 30% of our net worth. And that happened like clockwork every two or three years... it always happened. It has to happen with a concentrated portfolio, either because we were wrong in one or two of our picks, or because the market was out of favor for some period of time. And maybe it bothered us, maybe not if we had to be patient. But I would say that on the outside, when I was talking about people going in and out of funds and missing their shift, that's not conducive to other people, especially if they're not doing the work.

It was good for us and I think it was good for us because we knew what we had. And as long as the facts had not changed and as long as we believed in our thesis, we could accept it. I wouldn't say it was easy, but we could accept it. Now, on our bad days, we have hundreds of stocks on the long side and hundreds of stocks on the short side. We're trying to be right on average. We are buying good and cheap companies. We are shorting companies that are destroying capital, or losing money, or whatever.

And over time, that pays off. But our bad days, with hundreds of stocks on the sidelines, are 20 or 30 basis points of underperformance, not 20%, or 30% of our net worth. And so I think for most people, it's a smoother ride. And one of the big lessons that young investors (and many of you are still very young) can learn is compound interest tables. If you can get mid-teens returns, you wouldn't get 40% or 50% annualized returns, but on mid-teens returns, if you know the compound interest tables, you can do very well with one more trip. fluid over a long period of time.

One of the best examples, and when I taught those ninth graders, I actually put the outside of their notebooks, I handed them the notebooks. And on the outside I had a compound interest table. And I had the example of starting to invest $2,000 a year when you are 19, in your IRA, until you are 26, that is, seven years to save $2,000, and never put another nickel back, or starting when you are 26 and You contribute $2,000 a year for 40 years, until age 65. So people who contribute $2,000 a year from age 19 to 26 and never invest a nickel again end up with more money if they earn 10% a year. in that money.

They ended up with more money with those seven payments than people who started at 26 and made 40 payments, until they were 65. You end up with more money, between 19 and 26, that's just a very important lesson to learn about getting started. early. I know you are all over 19 so I'm sorry I didn't tell you this. But these kids weren't, which is why compound interest tables are important. So you're young...if you stick with a very methodical investment strategy that makes sense over time, you can still do very, very well. SPEAKER: So, Joel, thank you. You talked about the size effect, right?

By also entering hidden places and dark areas, he also talked about the temperamental advantage he can bring to the investment process. And then there is something to be said for the analytical and informational advantage. And there used to be a lot of investment in net payback. And do you think some of these advantages have become less, rather than more, relevant over time, and information has become almost universally accessible? JOEL GREENBLATT: Well, information - people have information about S&P 500 stocks. There's still a lot of groupthink going on. What I tell my students is that some of these smaller-cap companies... you know what happens if you're really good at doing things, like reading "You Can Be a Stock Market Genius" and buying some of these things in these dark places. .

And what I would call it is making unfair bets, not because you're really smart, but because you found it in a place where other people aren't looking. What happens to people who get good at it is that they make a lot of money and then they can't do it anymore because they have too much money. So it opens up a whole new area for young people to continue to enter. Certainly some of the smaller situations will always be there. Things can be a little more efficient, but there have been a lot of studies that... one of the big chapters I wrote was on spin-offs, which are companies that are sort of separate from... and they still work very well. .

But in a way it fails: they have studied, if you bought all the derivatives, how would you do? And they continue to surpass. That's not really the question. The question is: is this an area ripe for mispriced securities? If the average spinoff was average, that wouldn't mean anything to me. You're looking for the opportunity where people discard things or just aren't interested in things for reasons that have nothing to do with the merits of the investment. They may be too small. It may not be the company that the people who owned the original shares invested in.

Typically, companies that are not currently out of favor are discarded. So although on average, they have continued to do better than when I wrote the book, so that's not discouraging. But even if they had an average, they're still ripe for pricing errors, which is really what I'm looking for. So you're looking at these areas that are ripe for mispricing. There is no need to run a statistical model to decide whether, on average, they are doing well or not. If you know what you're looking for, you're looking for opportunities to find things that are priced incorrectly. And I don't think they will disappear.

But like I said, there are higher and better uses for most people's time. So I had a lot of fun doing that. I have a great time doing what I'm doing. If you don't want to do it, for meAlright. SPEAKER: In one of his recent interviews, I think he mentioned Apple, one of the big companies. And you believe that groupthink and incorrect pricing can occur even in large companies. So maybe Apple or some other company. I was wondering if you could walk our audience through an example of what metrics one should consider if they were analyzing a company.

JOEL GREENBLATT: Well, I'll go with Apple as a very broad picture. Have you heard about that? So at least I'm old enough to have owned a BlackBerry. And it used to have 50% of the market. Now it doesn't really exist. It wasn't that long ago. And the vast majority of Apple's profits come from its phone. That's the negative story about Apple: it's a hardware company. It'll crash and burn like all of them, okay? On the other hand, some people might say, oh, you have an ecosystem of products that compare to each other. They interact with each other.

It has a brand. I always say, hey, Coca-Cola doesn't make sugar water and they've maintained their brand pretty well. People tend to like Apple as a brand. And then the question is which one is it? Is Apple a hardware company or is it an ecosystem of products with a great brand? I'd say the answer is probably gray, somewhere in the middle. It's neither of the two. It's probably somewhere in between those two. But if you take a look at the market, I can see where the S&P is trading. I can see where Apple is trading.

And a few months ago... it's still very cheap, but a few months ago it was trading at less than half the valuation of the S&P. So as far as price goes, my answer is, if it's somewhere in the middle, I'd say it's probably better than average. And I buy it at half price. I don't know if that's the case, but I have a large margin of safety. I have hundreds of... what I'm saying is what we do now is I don't know the answer to your question. It's gray. I do not know the answer. I don't know if it's closer to a hardware company.

I don't know if it's an ecosystem with a brand attached, so it's much, much better. But interest rates are 2%. It has a free cash flow yield of 10% and earns high returns on equity. It has a great niche. What I would say is that I don't know if Apple is going to work, but I don't just own Apple. I have a bucket of apples. I own a group of companies with metrics like that: really cheap operations, with good capital deployment and good potential prospects. And then I don't know if Apple is going to work. I know my bucket of apples is going to work.

That was the graph I showed you. And that's why we own the apple bucket. But if you ask me my bet on Apple, I think it's cheap compared to other options right now. SPEAKER: Great, I just have a couple of questions, Joel, quick. You mentioned the index fund at the beginning of your talk. With all the money flowing into passive funds, ETFs and index funds, what would be your contrarian moves during a period like that? Are there things investors should be careful about, for example? JOEL GREENBLATT: Well, I already told you where I thought the overall market was - it's a market cap-weighted index, the S&P 500 was expensive, but I still expected positive returns going forward.

It is a world of alternatives. So the question is how should I invest my money? The move to passive can, with all the ETFs and everything else, cause dislocations in the short term, because people are not discerning. Remember, I said that stocks are not bouncing pieces of paper with Sharpe and Sortino ratios put on them. They are shares owned by companies and companies: there is a dispersion in their fundamentals, in how one is doing compared to another. When you simply take an ETF and don't distinguish the differences in fundamentals, that can cause dislocations in the short term.

That just makes me smile more because those dislocations mean, hey, I can find bargains because people stopped thinking. But I don't think they will get to that point, except in the short term. I think you already know: When the market drops and everyone gets depressed at the same time, they say correlations hit 1. That just means everyone throws the baby out with the bathwater. They don't make any discernment. But that really only happens for the first month, maybe two at most. And then there begins to be discernment. Actually, that is the time of greatest opportunity for us, when people begin to discern again.

And everything was moving at the same time, which shouldn't be the case. They all have different perspectives. And the same goes for ETFs, if there are flows into them or into the indices, that could cause short-term dislocations for a month or two, but they correct over time. Like I said, the market eventually gets it right. There are many...just think of the jelly beans. You really understand it. It's the jelly effect when everyone listens to what everyone else thinks. That happens most of the time. That's what the stock market is. Your job is to be cold, calculating and unemotional.

Unfortunately, people are human. It's good news for us, but people... the statistics are against it. That's why I think indexers get it right for the wrong reasons. They mostly say the market is efficient and have other explanations for why you can't beat it. I think that the market often gives you opportunities, but it is very difficult to take advantage of them due to behavioral and agency problems. And those are a lot more powerful than one might think just by saying, oh, behavioral issues and agency issues. People are people and this has been happening forever. I don't think it's getting better.

I think time horizons are getting shorter. There's so much... all that data, all that... look, when I started my first company in 1985, I used to write quarterly letters. And you read something like this: We were up 3% last quarter, thank you very much. That's what he said. Now we have donations of 10 billion and 20 billion dollars that we need to get our results weekly. I don't know what they do with them. But now we have to do it, and most of them do it well. But that's the world. So if you keep measuring things in shorter periods, and you can measure them, and there's more data, that doesn't make things better.

It makes you more susceptible to emotional influence. So that world is getting better. The last man standing is patience. We call it time arbitrage. Other people call it time arbitrage: just being patient. That's very lame and it's not getting better. Things go faster and with less patience. So that's really the secret. So now you don't even have to read the big secret. SPEAKER: I think a fantastic gift that you've given to the value investing community is the Value Investors Club. I'm sure most people here have already visited the website. If you haven't, check it out. It's an amazing resource.

Joel, if you could say something about the Value Investors Club, what is your vision for the future? And how do you compare or contrast it with other investment platforms that are emerging these days? JOEL GREENBLATT: Sure, well, it originally started in 1999. And the most important thing with the Internet back then was getting millions of eyes watching. And I looked at it more like, wow, I always wanted to be in an investment club. And I thought, hey, I could start an investment club where you can get together anytime, whenever you want, wherever you are, and share ideas about it.

And I'm always grading my students' work at Columbia. And at the time, there were Yahoo message boards where 99.9% of the material wasn't worth reading. So I said, hey, why don't we... along with my partner John Petry, I said, why don't we look at people who can join the Value Investors Club? And if you had gotten... maybe two or three people in the class each year would get an A+. And if you could write an investment thesis that I would have given an A+ in my class, you can join the club and it's free. All you have to do is share your best ideas.

You get to share a couple of your best ideas over the course of the year and that gives you the right to see other people's good ideas. And then it's just based on merit. And still only 1 in 20 applicants get in, so I think it's a little harder than Harvard. I don't know. But this has been going on for 16 years now. We have a... I think it's a 45 or 90 day delay if you're not a member, but to get live material, you have to be a member. So learn to value a business and apply for it, if you want.

There are instructions on the website. It's called the Value Investors Club. But as a learning tool, I always recommend people there because they are very smart investors. They hit each other. There's a Q&A after they post something and they're like, What's up with this? What's up with that? An excellent rating out of 10 is 5, because they are all bad and very... they are value investors. They are very hard and stingy. And then they don't... so if you look at the ratings and see something with a 5 or higher, that's good, these guys. And you can look at that.

It's just a learning exercise, right? It's teaching a man to fish. This is really how to be good at investing. It's nothing more. You have to understand what you are doing. It's a great way to learn. So I think for the next generation, it's a good way to teach them to look at what smart investors are doing now... it doesn't mean you agree with everything on the site. And this is a good point. I'm probably more wrong than right when conveying things. But Warren Buffett calls it uncalled strikes on Wall Street. You could pass up 100 pitches and you should have made 30 of them.

But if you just pick one and make sure it's good, that's really the way we invest. I just have to... my partner Rob Goldstein and I are very hard on each other. So we both have to like it. We both have to argue our points. And if we both like it, we think it's pretty good. So we're really picking our pitches. Doesn't mean we don't miss out on a lot of good ones. It doesn't matter if we miss them. It only matters that the one we choose is good. And that's the "You can be a stock market genius" kind of thinking about investing.

What we are doing now in our long and short portfolios is being more right on average. I showed you that graph where we're pretty good at valuing companies. So we bought a group of companies where we have a bucket of apples. And we are missing high-priced companies. We're going to be short on some money-losing things, or the Teslas and Amazons of the world, which sell for 100 times free cash flow. And people get confused, because I call that the tyranny of the anecdote. It's just that we will cut some incorrect ones. We will not fall short in many of them, but we will fall short in some, and we will be wrong.

And you will know their names because those were the winners. But if you're missing hundreds, trust me. It's not a good idea to burn through cash, lose money, or sell at 100 times free cash flow. And usually if you're generating a lot of cash, you can buy that cheap and they're investing their capital well, that's a good thing. So we just try to be right on average. Two different ways of doing it don't make one better than the other; There are different ways to earn money. I love them both, I would do both again. They are both full-time jobs.

SPEAKER: Great... and, Joel, our final question perhaps goes one step beyond assessment. In his books he has talked about different types of multiples that are used to value companies. He's talked about enterprise value relative to free cash flow; for example, EV to EBITDA is one such multiple. And many of those multiples, you say, have proven to be effective for long-term investments, such as when buying a bucket or a basket. The question is, however, due to the lack of a single source of accurate benchmark markets (because there are one-time charges and things to clean up), there are many sites on the web claiming a wide range of numbers. , some good, others not so much.

Have you thought about having a standardized implementation, perhaps open source, to compare these metrics over the long term, in the same spirit of magic formula investing, for example? JOEL GREENBLATT: Well, I think I'm a good guy, but not that good. So we have a team of analysts. We review every balance sheet, income statement, and cash flow statement of the companies we analyze. What is that deferred tax asset, or pension liability, or off-balance sheet plant in Taiwan? How should we handle that? How efficient are they in using and spending money? We do all that work. When I wrote "The Little Book," I called it the don't try too hard method.

It worked incredibly well using rough metrics (the kind you're talking about, rough metrics) and it worked incredibly well. My partner Rob and I looked at each other and said: This not only worked well. It worked much better with them, without trying too hard, than we thought. Can we improve that? In fact, we know how to value companies. Can we just do that? And we form a research team and we do it. It would be great if I shared it with everyone, but it's a lot of work. And the other way works incredibly well. SPEAKER: You're a good guy.

JOEL GREENBLATT: I'm a good guy and that's why we try to treat our customers very well. SPEAKER: On that happy note, thank you very much, Joel. It has been a pleasure. JOELGREENBLATT: Thank you very much. Thank you.